2023 (12) TMI 838 - HC - VAT and Sales Tax

Scope of contract - contract of services or a contract of supply and/or sale of software - requirement to follow decision of the Hon ble Karnataka Sales Tax Tribunal in the case of M/s. IBM India Pvt. Ltd. vs. State of Karnataka and the judgment of the Hon ble Karnataka High Court in the case of Saskan Communication Technologies Limited vs. Joint Commissioner of Commercial Taxes 2011 (4) TMI 566 - KARNATAKA HIGH COURT - failure to take into account the Affidavit dated 18.12.2014 as relevant evidence of conduct of the parties to the Agreement dated 1.1.2006 and to determine the nature of the services and the work performed thereunder - for removing or fixing of bug/error within the basic software which is in the nature of repair of the basic software amounts to development/enhancement/customization of the existing software or not. HELD THAT - It is clause 4 of the agreement that has been totally misunderstood and misread by both the Commissioner as well as the Tribunal. The lower authorities have purported to hold that the said clause shows that there is a transfer of software that has come into existence. On the contrary the aforesaid clause appears to be when the contract is read as a whole a standard clause inserted into such contracts for repair and service and is a clause it appears to have been inserted by way of abundant precaution to overcome a situation where the service provider would misuse the QAD software or claim ownership over the same. In fact this clause shows that appellant had neither any ownership of the original software nor ownership of anything that came into existence whilst resolving customer issues. The said clause on the contrary shows that from the very inception everything belongs to QAD and the moment anything comes into existence by virtue of any work done by appellant s employees the same is deemed to have always been owned by QAD and appellant is not deemed to be the author of anything done. In fact appellant was not even entitled to utilize any such work or material or product that may have come into existence and there could have been no question of any sale as nothing belongs to appellant. When nothing belongs to appellant it is not possible to come to the conclusion that there was a transfer of goods or a sale as held by the lower authorities. Assuming that any software has been developed or there is some change in the source code no new or saleable software comes into existence. Appellant s employees had merely worked on the old software remotely as the same is located on QAD USA s server situated in the USA. The alteration in such software is to meet the requirements of the QAD India s customer which at all times belonged to the QAD India. There is no sale to QAD India and no sale was involved in the contract. In fact the terms of the contract makes it clear that the contract was one for rendering service. In fact even before rendering any service appellant had given up their right to any development to the software. The consideration involved is not for the sale of any software but for the services rendered by appellant s employees. All IT property rests with QAD India. Mastek Limited case relied upon by the Tribunal is not applicable to the facts and circumstances of the case. In the case of Mastek Limited Mastek was required to use its professional intelligence to solution the requirements of HDFC for its Home Loan Applications; evolve a software programme to meet the requirement of the HDFC and encode a programme on its medium. HDFC s source codes were shared unlike in appellant s case to do the required alteration and modification to develop a programme which will meet functional requirement of HDFC. The software programme so developed was owned by Mastek and was then subsequently sold to HDFC through a medium. Hence there was clearly a sale in this case. Even the judgments in the matter of Direction Software Solutions V/s. Income Tax Officer 2008 (4) TMI 332 - ITAT BOMBAY-E and ISBC Consultancy Services Ltd. V/s. Deputy Commissioner of Income Tax 2002 (8) TMI 840 - ITAT MUMBAI relied upon by the Tribunal are not applicable to the facts and circumstances of the case. The reliance by the Tribunal on these two decisions is totally misplaced. These were cases where the assessee(s) contended that they had developed software and were entitled to a deduction in terms of Section 10A of the Income Tax Act 1961 which defined computer software to mean inter alia any customised electronic data or any product or service of any similar nature which is transmitted or exported from India to any place outside India by any means. It has been clarified by appellant that other activities captured side agreement development of Just in Time Sequencing Product or development of any other OAD product was never undertaken by appellant. The Karnataka Appellate Tribunal in IBM India Private Limited Bangalore when discussing levy of VAT by activity performed by ERP Implementation Specialists noted that the codes which such Professionals insert in that software are not proprietary codes having a marketability of their own which the concerned customer can possess or transfer or sell. In other words there is no marketable commodity in existence to be sold and unless such commodity whether tangible or intangible exists there cannot be a sale or a works contract. This aspect was summarily dismissed by the Tribunal and the proprietary nature of the ERP software was not duly considered - The case at hand is also similar to the one dealt by the Hon ble High Court of Karnataka in the case of Sasken Communication Technologies Ltd. The Tribunal distinguished this judgment on the ground that in this particular case the ownership vested with the customer from the very inception. A true and proper reading of Clause 4 of appellant s agreement with QAD India it would be absolutely clear that from the very inception all property is owned by QAD India and vests with QAD India. No doubt that at the end of the day the software which is developed is embedded on the material object that exclusively belong to QAD. In the entire contract there is nothing to indicate that appellant after developing any software has to embed the same on a material object and then deliver the same to the customer so as to affect title to the project which is developed. The title in any case always lived and vested with QAD. The pith and substance of the contract or true nature of the transaction shows that the contract is a contract for service simplicitor and is not a works contract or composite contract consisting of 2 contracts - one for service and one for sale but is an indivisible contract for service only. On examination of the contract as a whole it becomes obvious that the contract is essentially an agreement to render service. The theory of works contract or the concept of aspect theory is not attracted. The questions of law as framed by this Court on 8th December 2015 are answered in favour of appellant. The agreement dated 1st January 2006 between appellant and QAD is a contract of service and would not be a contract for sale as defined under Section 2(24) of the MVAT Act. Appeal disposed off.

Summary

Issues Involved:
1. Nature of the Agreement: Contract of Services or Supply/Sale of Software?
2. Applicability of Precedents from Karnataka Sales Tax Tribunal and High Court.
3. Consideration of Affidavit as Relevant Evidence by Tribunal.
4. Classification of Services Provided: Repair/Maintenance vs. Development/Enhancement/Customization.

Summary:

Issue 1: Nature of the Agreement
The High Court examined whether the agreement dated 1 January 2006 between the appellant and QAD India Private Limited was a contract of services or a contract of supply and/or sale of software. The court concluded that the agreement was a contract of service. The appellant provided manpower for maintenance and support of QAD's ERP software, MFG/PRO, without transferring any ownership or creating new software. The court emphasized that the appellant did not have access to the source code and was only involved in bug fixing and maintenance.

Issue 2: Applicability of Precedents
The appellant argued that the Tribunal erred by not following the decisions in M/s. IBM India Pvt. Ltd. vs. State of Karnataka and Saskan Communication Technologies Limited vs. Joint Commissioner of Commercial Taxes. The court agreed, noting that the facts of the present case were similar to those precedents. The Karnataka High Court had held that services like bug fixing and maintenance do not constitute the sale of software but are service contracts.

Issue 3: Consideration of Affidavit as Relevant Evidence
The appellant contended that the Tribunal failed to consider the Affidavit dated 18.12.2014, which was crucial in determining the nature of the services provided. The court found that the Tribunal, being the last fact-finding authority, erred in not taking the affidavit into account. The affidavit clarified that the appellant's role was limited to providing services without altering the core software.

Issue 4: Classification of Services Provided
The court examined whether the services provided by the appellant under the agreement amounted to development/enhancement/customization of software. It was determined that the services were purely for repair and maintenance, specifically fixing bugs/errors, which did not result in the creation of new software. The court referenced the judgment in Thermax Babcock & Wilco Limited vs. State of Maharashtra, which held that intellectual services for corrective actions are service contracts and not subject to sales tax.

Conclusion:
The High Court concluded that the agreement between the appellant and QAD was a contract of service, not a contract of sale. The Tribunal's decision was set aside, and the questions of law were answered in favor of the appellant. The appeal was disposed of accordingly, with no order as to costs.